Never have so few central bank and regulatory technocrats done so much damage with pseudoscientific mumbo jumbo.

Sir, James Grant writes: “We live in an age of pseudoscience. The central banks’ forecasting models have failed to predict the future. Quantitative easing and zero per cent interest rates — policy centrepieces of the post-2008 era — have failed to restore what we used to call prosperity.” “Magical thinking divorces markets from reality" July 21.

Absolutely, but that pseudoscience has its roots in other even worse mumbo jumbo, namely the Basel Accord’s credit risk weighted capital requirements for banks.

With these requirements silly regulatory experts thought they could make banks safer, by allowing these to leverage more their equity for what is ex ante perceived as safe than for what is perceived as risky… as if those perceptions were not already cleared for by other means.

That distorted the allocation of bank credit to the real economy… and sent banks to build up against very little capital, huge exposures to what is ex-ante perceived as safe, precisely the material of which major bank crises are made of… and stopped the banks from lending to those most in need of bank credit like SMEs and entrepreneurs.

The quantitative easing and the zero interest could even have been somewhat effective, had only Basel’s regulatory distortions been removed. Unfortunately that would have made it necessary to admit what was done wrong, and since it is basically the same little group of members in a mutual admiration club that are responsible for both QEs zero interests and bank regulations, we can’t have that… can we?

History will be clear about that never before have some so few technocrats done so much damage. And history will of course not be kind to those who having been informed about it, like FT, nevertheless decided to keep mum.

@PerKurowski

Regulators have purchased the illusion of bank safety, by forbidding these to finance the risky future.

Regulators have purchased the illusion of bank safety, by forbidding these to finance the risky future.

Sir, I refer to James Grant’s “Low rates are jamming the economy’s vital signals” October 13.

When Grant writes: “What is new today is the overlay of officially sponsored bull markets on governmentally suppressed interest rates”, he is quite right.

And when he writes: “True prices are discovered, not administered. They are set in the open market…. The world should spare some censure, too, for the central banks’ manipulation of money market interest rates, their heavy-handed administration of longer-dated bond yields and their sponsorship of rising share prices. Just because the public servants do their well-intended work under the banner of the law does not make the results any less subversive”, he is also quite right.

Unfortunately, what Grant misses in order to make the public servants “subversive” activities much clearer… is what is most jamming the economy’s vital signals, namely the credit risk weighted capital (equity) requirements for banks.

That regulation allows banks to earn much much higher risk adjusted returns on equity when lending to what regulators, with immense hubris, feel can be designated as “absolutely safe”, than for what they, with equally immense hubris, feel can be designated as risky. And that, instead of negating the efficient market hypothesis like so many hold, included Nobel Prize winners, has impeded the efficient open markets to work.

Grant concludes: “Central bankers… have purchased short-term relief with long-term instability”. I wish not to argue with that but, as I see it, what central bankers and regulators have most purchased, is the illusion of bank safety, and this by paying the price of forbidding the banks to do what they are most supposed to do, namely to finance the risky future, hopefully with reasoned audacity… since otherwise, as we know, the present will stall and fall.

PS. Grant should also try to figure out how the fact that banks on loans to the "infallible sovereigns" need to hold much less capital than against anything else, subsidizes the "risk-free rate".

Bailouts and the socialization of losses is not the responsibility of banks but of governments, and what banks really must do, is to relearn the ancient art of lending to “The Risky”

Sir, James Grant writes “Banks need to rediscover the ancient art of caution” December 14, and mixes up any ex-ante behavior of banks, which is their responsibility, with the ex-post socialization of their losses, which is entirely the responsibility of governments. 

Also, were not our current predicaments so sad, it would almost be funny when Grant preaches “A good banker lent against the collateral of short-dated commercial bills, not heaven forfend-property”, and as if implying that the banks had been out on a very risky bungee-jumping tour. 

Does Grant really believe that holding triple AAA rated securities backed with mortgages, and to which the banks were authorized by their regulator to leverage their equity 62.5 to 1, so safe were these, and for which there was an immediate mechanism to obtain liquidity by selling these in a market that very much demanded these securities… evidenced a lack of caution? Is it not an excessive regulatory risk-adverseness against all perceived as “The Risky” and which drove the banks excessively into the arms of “The Infallible”, precisely the spot where all bank crises have always originated. 

No, the problem is that bank regulators, with their capital requirements based on perceived risk, gave the honest bankers an additional motif to behave just like Mark Twain describes them, namely those who lend you the umbrella when the sun shines and want it back when it looks like it is going to rain. And as a consequence banks got caught with excessive exposures to “The Infallible” with no capital at all. 

On the contrary, what bankers must now with urgency relearn, is the art of lending to “The Risky”, like unrated small businesses and entrepreneurs but, for that to happen, we first need to rid ourselves of nervous regulatory nannies who want banks to deal exclusively with “The Infallible”, triple-A rated and sovereigns (like Greece).

God make us daring!